19 September 2011

Occupational Fraud Risk: UBS Rogue Trader...

Kweku Adoboli, is no different than any other person who commits fraud. At UBS, this trader understood the controls that were in place to prevent the kind of naked unhedged bets that he was making in the market. UBS or any other firm is subjected to the testing by those people who are looking for the method and opportunity to circumvent the controls to commit fraud. Motivation is another topic.

In other words, this case very closely resembles that of Bernard Madoff, the man who has been described as the investment equivalent of Charlie Manson. Madoff told his clients, business partners and regulators that he was trading in a whole variety of stocks—when in fact the trades never took place. They were simply made up—as were the phony gains to client portfolios.

Here it seems that Adoboli was also able to simply make up trades and cover up the fact that he was not hedging. His trades involved UBS's funds, rather than that of clients. But if you are a UBS wealth management client you have to at least wonder whether any part of your portfolio is based on trades that were never actually made. If Adoboli could do it, certainly others could as well.

Now the question needs to be asked to their auditors. How is this possible? What controls failed and why? The analysis of the incident will slowly unfold and other firms in the industry will be examining the method and process that was utilized at UBS to perpetuate this fraud over the course of three years. When a fraud of this size is finally revealed, it is no different than the others that have preceded it. Many will ask about the systemic Operational Risk issues that may be prevalent within the UBS culture.

Three years ago it all began. And so goes the typical story line on the epic tales of fraud in the years past and the decades to come. Effective oversight and risk management walks a fine line between enabling innovation and insight and mitigating errors, omissions and significant losses. One thing is certain, the "Insider" threat in your organization exists today, tomorrow and next week. It's not going away regardless of the number of controls, personnel or systems put in place to eradicate it's existence in your institution.

Whether this incident will end up in the Fraud Museum is yet to be determined. What is more certain is that traders around the globe are under a new spot light and renewed scrutiny by oversight investigators. The goal now is to make sure that the combination of people, processes, and systems are fine tuned to the right tolerance levels and triggers for alerts. Only then will the correct balance occur between risk and reward.

What will certainly be an outcome of the investigation is the number of other people that will be implicated, either directly or indirectly by the incident itself.

Jerome Kerviel of Societe Generale and Bernard Madoff, will have a new member for the multi-billion dollar fraud club, Kweku Adoboli. What do all of them have in common according to the Association of Certified Fraud Examiners (ACFE) in the Report to the Nations:

Perpetrators of Fraud

  • High-level perpetrators cause the greatest damage to their organizations. Frauds committed by owners/executives were more than three times as costly as frauds committed by managers, and more than nine times as costly as employee frauds. Executive-level frauds also took much longer to detect.
  • More than 80% of the frauds in our study were committed by individuals in one of six departments: accounting, operations, sales, executive/upper management, customer service or purchasing.
  • More than 85% of fraudsters in our study had never been previously charged or convicted for a fraud-related offense. This finding is consistent with our prior studies.
  • Fraud perpetrators often display warning signs that they are engaging in illicit activity. The most common behavioral red flags displayed by the perpetrators in our study were living beyond their means (43% of cases) and experiencing financial difficulties (36% of cases).

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